I believe people should have to prove themselves before they can manage other people's money and the best evidence of investment skill is a track record. That's why I require the Marketocracy Masters to outperform the S&P 500 for a minimum of 5 years before their model portfolios are used for clients with separately managed accounts.
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Can American Airlines Double?

American Airlines is flush with plans and accomplishments including a recently completed merger with US Airways, a brand new operations center to be built in the Dallas/Fort Worth area by 2015, and purchase orders submitted for at least 42 new 787 Dreamliners. Management says it is emerging from its recently completed bankruptcy in a position to take on the world. But for investors, the key question is can American Airlines double within a reasonable timeframe?

Marketocracy Master Justin Uyehara considers American Airlines to be a good choice right now and recently discussed with me his take on why he is buying American Airlines as a holding position, while he waits for a broader market turnaround. You can view Justin ‘s top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.

Justin’s Marketocracy model portfolio has averaged 30% a year for 13 years. (Photo credit: bigstockphoto.com)

Justin believes that the market is moving toward “safer stocks,” specifically large cap, value stocks that are broadly covered during this current market correction, as a way to hedge their bets until a true growth phase kicks back in. Justin is taking advantage of this in his portfolio by finding undervalued stocks in this space, and he believes that American Airlines is one of them.

In our conversation, he cited the slowdown in Europe and China as a huge factor in the stabilization oil prices, and while the rest of the airline industry is trading at a 13X or more multiple of earnings, American is only trading at a 7.7X multiple. He sees this as an opportunity. I wanted to reach out to our talented investment research community to get their feedback as well and see if this idea about American Airlines was prevalent among our members. So, last week, I posed a series of questions to the community about American Airlines. We asked them for their insights through the following questions.

How is American Airlines different from its competitors, like Delta (NYSE:DAL) and Southwest (NYSE:LUV)? What do you think American Airlines most valuable competitive advantage is?

What was your rationale for adding American Airlines to your portfolio?

What do you think American Airlines has to do to deliver a double in the next 3-5 years?

Our philosophy at Marketocracy has always been to find the best investors in the world and listen to them. When it comes to researching stocks, the opinions I value most highly come from those who have exceptional, long-term track records.

Here are some great insights from members who have proven their talent with their track record over time.

Jeff McDowell has a 13-year track record at Marketocracy, and has made over $760,000 on American Airlines.

“American Airlines has nine hubs in the continental U.S. and its capacity to scale upward is unmatched by the other airlines. Southwest is still regarded as a discount airline, but that cachet is fading as it has matured and taken on more traits of the legacy airlines. I added its predecessor U.S. Air (along with other airlines) years ago based primarily on pricing power. Among the legacy airlines it has the least institutional ownership, which is due in part to bankruptcy unknowns (prior to merger) and skepticism on a successful integration (post-merger). Three consecutive quarters of profit from post-merger operations will attract the interest of a new wave of investors. “

Jeff has two great points in his comments. First, American Airlines’ hub structure is unmatched in the United States. They also have a very favorable structure internationally, with good locations in China, South America, and Europe. The second great point that Jeff makes is their current lack of institutional investors. This dearth of institutional ownership is keeping the price low compared to the rest of the industry.

George Scombulis has an 8-year track record with Marketocracy, and while his returns have not been very substantial (only $14,598), he makes some very good points in his response to our questions.

“In my opinion, American Airlines is the leader in the category of U.S. owned airlines with international travel flights, and it has a virtual monopoly. It is a well-positioned, large-cap name that several of my portfolios call for, but it is the economy of scale of the international travel that makes it very attractive. The merger has worked quite well, and will continue to do so, especially in the near future.

The mainline carriers of United, Delta, and American have longer routes—including international routes. United, Delta, and American also generate more revenue per seat mile due to higher pricing in these routes. Southwest is in the middle, with few international routes and point-to-point. The regional and low-cost airlines fly fewer miles and receive less revenue per mile. It is the economies of scale on the international routes where American Airlines really sees their returns. My confidence in the position is further enhanced by recent notes from the American Airlines Group’s annual shareholder meeting on June 4 2014:

CEO Doug Parker reigned over the meeting with shares of AAL up over 70% since the combination of AMR and US airways, and for the most sailed through the Q&A part of the session.

He stated that the company will consider making some moves to boost shareholder returns.

He noted the American Airlines is on track to achieve the promised $1B in net synergies from its merger.

In addition, American Airlines is expanding its network in China by operating five daily flights between China and the U.S. beginning in the second quarter of this year. Moreover, by the end of this year American Airlines will modify its current set of fleets by adding more slim-line seats to reduce fuel expenses. These strategies will enable American Airlines to increase its total revenue, which will help it compete with its rivals.

Also, on June 5, the company announced a partnership with GOGO to offer in-flight wi-fi on its regional jets, which is further indication that Doug Parker will make good on his pledge to make moves to boost shareholder returns.

AAL’s ability to deliver a double is greatly impacted by the price of jet fuel. Generally, this can be 30% to 35% of expenses for an airline. How well American Airlines will be able to hedge its fuel costs will be the key.

Lastly, taking this back to fundamentals, the S&P is trading at 12.7x trailing 12-month EBITDA. The airline industry is trading at 6x trailing 12-month EBITDA. The airline industry has restructured. Overall, the industry’s ROIC is greater than its WACC. Assuming the U.S. and global economy continues expanding, you could see the airline industry coming into alignment with the S&P 500 index, which would provide a good return with American Airlines on the point of the formation.”

Economies of scale, stabilized fuel costs, and international leadership are all of the key points that George brings out in his response to our questions.

American Airlines is now the largest airline in the world, with more international flights and hubs than any other. Their route structure and international placement give them a competitive advantage over their peers as they emerge from the bankruptcy and merger in a much stronger position.

If they can capitalize on their advantages in routing and hubs, take advantage of economies of scale that they have achieved through their merger, and expand back into the areas such as South America and China, where they were once the dominant and premier carrier, they will attract more investors, especially institutional investors, delivering value for all of their shareholders in the form of price appreciation on their stock.

My Take:

Justin is not looking for a double in American Airlines. But, he believes AAL is a solid play in the large cap space that has some room to run. Our community has confirmed that with their competitive advantages, new pricing strategies, new aircraft, and new markets to explore, American is a solid place to invest while waiting for the next long term idea to come through.

After posting a return north of 60% last year, Justin has under performed this year. But, the best time to invest in Justin’s portfolio may be in fact be after a period of under performance and after he’s had a chance to reposition his portfolio to adapt to changing market conditions. When you have a manager like Justin, with such a great track record, it is hard to bet against him for the long term, especially when the rest of Marketocracy’s community seems to agree with him, and the data seems to support his choices.

Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.

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